Wall Street provided an unwelcome reminder of the financial challenge facing Barack Obama as it marked the new president's inauguration with a stock market plunge led down by a renewed crisis of confidence in US banks.

The Dow Jones Industrial Average suffered its worst one-day drop since December 1, slumping by 332 points to 7,949. It was the blue-chip index's first fall below 8,000 since November and all 30 Dow components were in the red by the end of the day.

Britain's struggle to bail out banks aggravated fresh soul-searching on transatlantic markets over the viability of leading US institutions without significant further public aid. A disclosure of huge potential losses at Boston-based State Street contributed to the rout.

It was the worst inauguration day in US history for stock prices according to figures compiled by Bloomberg and the Stock Traders' Almanac, with none of Washington's optimism spilling through to the financial sector.

The new president's inaugural speech briefly lifted shares, although they tumbled downwards as the afternoon progressed. Obama reasserted his desire for tougher regulation, saying that the present crisis was a reminder that "without a watchful eye, the market can spin out of control".

Anxious traders compared the gathering sense of foreboding to the near panic which swept through markets in September in the weeks following the collapse of Lehman Brothers.

"The market doesn't trust that banks have properly marked their balance sheets and their loan portfolios," said Robert Patten, a banking analyst at Morgan Keegan. "The sense is that there are further marks to come, that tangible book [value] is not as it is stated today."

The money management firm State Street became the latest firm to be dragged into the mire as it revealed unrealised investment losses of $10bn on instruments such as commercial paper – short-term debt issued by companies.

State Street, which has 28,000 staff worldwide, announced a 71% slump in quarterly profits to $65m and the company's shares dived by 59%.

Gerard Cassidy, an analyst at RBC Capital Markets, said investors were "spooked" by the 217-year-old firm's predicament: "For State Street, this is the worst news we've ever seen in a day by far."

Standard & Poor's cut its credit rating on State Street, which had hitherto been viewed as one of the healthier of America's major financial institutions.

Underlining the severity of the change in market sentiment, the VIX index of volatility, known as Wall Street's "fear index", leapt by 22% to 56.39 – its highest since mid-December.

The economist Nouriel Roubini, who was credited with foreseeing the present crisis, told a conference in Dubai that losses in the US financial system could hit $3.6tn before the credit crunch ends – which, he said, means the entire US banking system is effectively bankrupt.

"If that's true, it means the US banking system is effectively insolvent because it starts with a capital of $1.4tn," said Roubini. "This is a systemic banking crisis."